The real estate crisis traps China in a paradoxical market

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Here is a scenario. You buy a pre-construction apartment and start paying the mortgage before it’s finished. The developer stops the project, has defaulted on its debt and it seems that the property will never be built. You hear of buyers elsewhere who have stopped repaying their loans; the government has stepped in to ensure builders have money and is considering granting temporary vacancies to mortgage borrowers. What are you going to do?

This sums up the dilemma for the Chinese government to come to the aid of buyers in stalled real estate projects. An effort to short-circuit the spread of mortgage boycotts risks fueling exactly the behavior it is trying to prevent. Authorities had no choice but to do something, given the growing market alarm, and their intervention sparked a relief rally in real estate and banking stocks on Monday. Whether this marks a turning point or simply a pause before the next stage of the real estate crisis remains to be seen.

The numbers, at first glance, suggest limited cause for concern. The affected loans represent less than 0.01% of outstanding residential mortgage loans at most Chinese banks, according to Fitch Ratings. Up to 2 trillion yuan ($297 billion) in advances could be affected, Bloomberg News reported, according to GF Securities Co. Even that, which is a measure of assets rather than potential losses, barely represents 5% of the 38.8 trillion yuan of outstanding mortgage loans in China. If every buyer defaulted, it would lead to a 388 billion yuan increase in nonperforming loans, Jefferies estimates.

This does not mean that the anxiety is misplaced. Everything but. After more than two years of living with the pandemic, everyone knows better the implications of exponential growth rates. The mortgage boycott began in late June with a single China Evergrande Group project in the city of Jingdezhen. That grew to 28, then 58, then at least 100 developments in more than 50 cities as of July 13. On Sunday, the tally was at least 301 projects in about 91 cities. Capital Economics estimates that construction of about 13 million apartments has been halted over the past year, potentially affecting more than 4 trillion yuan in mortgage debt. Even if all of this could be supported, it is unclear how such a loss of confidence could mutate and infect other parts of the financial system.

Equally troubling is the emergence of such non-payment tactics in the first place, a strain of behavior hitherto unknown in China. The country has long been considered immune to the kind of self-reinforcing mortgage spiral that led to the subprime mortgage crisis in the United States. When you’re a fruit picker on loan 50 times your salary to buy a $750,000 house with no down payment, it’s not hard to leave if the market turns south. China’s property market is a very different animal, with first-time buyers being required to pay 30% of the purchase price, at least until regulations are relaxed earlier this year.

When homeowners spend so much of their wealth to get a loan, it takes something catastrophic to cause them to give up. In Hong Kong, which had similarly onerous down payment rules before the Asian financial crisis, mortgage defaults have remained low even as house prices fell more than 60% from the end 1997, with the delinquency rate peaking at 1.43% in 2001. In China’s second-tier cities, where mortgage boycotts have been concentrated, prices for newly built homes show nothing comparable to this magnitude of decline , although the trend is clearly negative.

Of course, the concern of mortgage strikers is not the decline in value of their investment, but whether they will receive what they paid for. With a record wave of development defects and home sales stuck in a prolonged slump, that’s a tangible fear. It’s hard to fault them for taking such a tough approach. Beyond a desire to cut their losses or pressure property companies to deliver, some buyers may have their own cash flow issues amid the economic downturn, said David Qu, a Hong Kong-based economist at Bloomberg. Economics.

The broader behavioral consequences of the homebuyer revolt can only be guessed at. Property is by far the most important store of wealth for most Chinese landlords and is at the heart of the unspoken social contract that the Communist Party will guarantee an ever-higher standard of living in exchange for acquiescence to its rule. In the past, owners who bought the first lots of a new project were known to show up and trash the sales office after the developer cut prices for later installments.

This is the paradox of this latest rescue measure. The financial distress plaguing the real estate market is the result of the government’s attempt to impose greater market discipline on developers and stop the relentless buildup of leverage. While the victims may deserve this time, the intervention keeps China locked in a scheme to protect investors from the consequences of a market failure. That’s probably even better than letting their faith in the system implode.

More from Bloomberg Opinion:

• China’s mortgage boycott brings back strange memories: Shuli Ren

• China falls in love with skyscrapers: Adam Minter

• This Potemkin property tax is going nowhere: Matthew Brooker

This column does not necessarily reflect the opinion of the Editorial Board or of Bloomberg LP and its owners.

Matthew Brooker is a Bloomberg Opinion columnist covering Asian finance and politics. A former editor and bureau chief of Bloomberg News and associate business editor of the South China Morning Post, he is a CFA charterholder.

More stories like this are available at bloomberg.com/opinion

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